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Proposed Solutions
Mortgage securitizations are managed by a contract called a “Pooling and ServicingAgreement” (PSA). A PSA is the basis for the securitization and binds investors, as theproviders of capital, with the issuers, as the consumers of capital. This is not the contractof the homeowner with either the bank or the firm that originated the loan. Instead, aPSA may cover thousands of loans and is the contract that specifies a Servicer’sobligations to bondholders and spells out a Servicer’s authority and ability to restructuremortgages. The contract that I was, and am still, seeking to ensure that Congress remainsfocused on is the PSA. Let me offer some recommendations of how the Hope forHomeowners (HHO) program may be improved, given the existence of these contracts.The HHO program allows Servicers to renegotiate loans to the lesser of 90% of marketvalue or 31% of the homeowner’s income as a loan payment in cases where suchrenegotiation is a better outcome than foreclosure. The question, though, is whodetermines what is the better outcome? Renegotiations are in the hands of the Servicers,who have financial incentives to avoid foreclosure, regardless of the outcome. Keepingsomeone in their home is cheaper than foreclosure for the Servicer, even if it createsgreater losses for the mortgage investor. Furthermore, there may be other financialbenefits to Servicers for each loan that is renegotiated. Finally, all participants in themortgage market are under political pressure to have homeowners stay in their houses.One need look no further than the letter I received from this Committee on October 24
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to see evidence of the intensity of this political pressure (Tab 1).In the current form of the HHO program, there is effectively no oversight for objectivelydetermining the better outcome. Servicers that have much to gain from the renegotiationof mortgages have an incentive to pass unjustifiable losses onto investors. Supposedly,investors’ interests are protected by the Trustee of the mortgage securitization. However,in all PSAs with which I am familiar, the Trustee is indemnified for servicing errors.There is no party watching out for the bondholders’ interests and decisions are left in thehands of the Servicers, which often created these problems in the first place throughfraudulent loan originations.If the HHO program is seen as encouraging Servicers to restructure mortgages beyondthe limits in the PSA contracts, the program could create serious new liabilities for theServicers. These Servicers, which are largely banks looking for ways to increase feeincome and reduce expenses, have strong incentives to engage in mortgage restructuringat the expense of bondholders.In the context of our current housing crisis, it is essential to be clear about who are theinvestors in residential MBS. These investors are not only investment banks, collegeendowment funds, and sovereign wealth funds, but ordinary Americans in significantnumbers. Investors in private label MBS include pension funds, public retirementsystems, private sector retirement funds, and individual investors from all walks of life.To hold MBS does not automatically make one a “hedge fund” investor, but more likelyan everyday, investor investing in the fabric of American life.
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